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Ontario staggers under burden of fiscal federalism

Province can no longer afford to pay more than its fair share.

By Matthew Mendelsohn

Tues., March 6, 2012

The Drummond report’s chapter on “Intergovernmental Relations” has received little attention so far. That needs to change. The chapter provides a devastating, evidence-based case that lays a lot of the blame for Ontario’s fiscal woes on the steps of the federal government.

When Premier Dalton McGuinty complained on Monday about federal decisions that are having a disproportionate effect on Ontario, he actually had the evidence on his side.

Chapter 20 of Don Drummond’s report begins by noting that in 2009-10, Ontario, with 39 per cent of the Canadian population, contributed 39 per cent to federal revenues, but benefited from only 34 per cent of federal spending — a gap worth about $12.3 billion or 2.1 per cent of Ontario’s GDP. The report concludes that this — among other factors — demonstrates the “perverse structure of Canadian fiscal federalism.”

Such a drain of fiscal resources from Ontario may have at one time been justified. It was the burden of prosperity that Ontarians gladly paid in the 1970s and ’80s.

Today, as is well known, Ontario’s fiscal capacity is below the national average. However, despite receiving equalization this year, Ontario, along with Alberta and B.C., are the only net fiscal contributors to the federation.

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This is no longer sustainable. The operation of fiscal federalism and federal spending decisions that take money out of Ontario at a time when its fiscal capacity is below average is indeed “perverse” and should offend Canadians’ sense of fairness.

Over the past decade, the federal government sucked 2 to 4 per cent per year out of Ontario’s GDP for the purpose of regional redistribution. We are now seeing the long-term impact of federal policy on Ontario’s economy.

Ontario has the largest deficit in the country. This is not because of higher than average spending. In fact, Ontario spends less per capita than any other province. In 2009, Ontario spent just $9,030 per capita, well below 9th placed B.C., which spent $9,689. Newfoundland and Labrador ($13,466) and Saskatchewan ($11,848) were the biggest spenders and, despite surging resource royalties and above average fiscal capacity, both continue to be significant beneficiaries of federal spending. With resource revenues and generous federal spending decisions, it is not surprising that they spend more than other provinces.

This is the backdrop to Ontario’s efforts to bring down its deficit: It already runs the least expensive, most efficient programs in the country. It has to. Because of the operation of federal transfers and spending, Ontario has fewer dollars to spend, in a virtual tie with P.E.I. for lowest fiscal capacity among provinces.

The Finance Canada data presented in the Drummond report are clear: Ontario has less ability to deliver the same level of public services as other provinces because of federal decisions.

The absence of ballooning resource royalties in Ontario and the relative weakness in the Ontario economy have slowed but not stopped the redistribution of Ontario’s wealth to provinces with greater fiscal capacity. Perverse indeed.

The toll from federal policies that drained funds from the Ontario economy is now being felt. Higher university tuitions, less infrastructure spending, more user fees. Ontarians continue to bear an unfair burden from federal regional redistribution.

The solutions proposed by Drummond are straightforward: end the unprincipled clawbacks to the equalization program that have deprived Ontario of needed funds; undertake broader reform of fiscal transfers; allocate money for everything from labour market training to infrastructure to social housing fairly; reform key programs like employment insurance that siphon money from Ontario workers and businesses; compensate provinces when the federal government downloads costs through legislation like the omnibus crime bill; and avoid unilateral federal changes to the tax code that must be mirrored by provinces and that hit a province’s bottom line.

The continuing wealth transfer from Ontario has become a pressing national issue. Policies, cultural habits in Ottawa and allocation formulas established long ago are no longer justifiable — and they are doing long-term damage to the Ontario economy. The data in the Drummond report make this increasingly clear.

I suspect that most Canadians would be genuinely surprised to find out that federal spending and transfers continue to redistribute money away from Ontario, rather than toward it. I also think that this would genuinely offend their sense of fairness. Canadians support the notion that provinces with below average fiscal capacity should benefit from federal transfers. Right now, Ontario continues to pick up the tab.

Most of the attention on the Drummond report has been understandably focused on what Ontario needs to do to return to balance. However, the report makes a pointed case for federal action as well. Ontario needs a federal partner willing to acknowledge its role and do its part. Without this key ingredient, Ontario faces an even steeper climb out of its fiscal hole.

Matthew Mendelsohn is director of the Mowat Centre at the School of Public Policy and Governance, University of Toronto.

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